Accounting for financial asset – RecognitionWhen to recognize?On balance sheet date andWhen the entity becomes party to the contractual provisions of the instrumentFor example: an entity becomes party to contractual provisions when it commits topurchase securities or to write derivative option.Planned but not committed future transactions, no matter how likely they may be, are notfinancial assets or liabilities.For example: an entity’s estimated but uncommitted sales do not qualify as financialassets or liabilities.Timing of recognition of financial assetIt depends on whether the accounting is done by•Trade date•Settlement date.
Trade date accounting:Financial asset purchased is recognized on the trade date along with simultaneousrecognition of related liability to pay for it.Financial asset sold is derecognized on trade date along with recognition of gain/losson sale of that asset and related receivables.If the financial asset is interest bearing instrument like debt or bond, interest does notaccrue on and from trade date.Settlement date accounting:Financial asset purchased is recognized on settlement date along with simultaneousrecognition of liability to pay for itFinancial asset sold is derecognized on settlement date along with recognition ofgain/loss on sale of that asset and related receivables.
An important issue is the accounting treatment of fair value change between the tradedate and settlement date.Example: A ltd purchases a financial asset as on 29th March 2012 for Rs 100 lakh. Thefair value of the asset on 31st March 2012 (year end) and 2nd April 2012 (settlementdate) are Rs 105 lakh and Rs 103 lakh respectively. Accounting treatment of thetransaction would depend upon classification of the financial asset.
Trade date accounting:Date HTM investment AVS asset re- Assets at FVTPL re- carried at amortized measured at fair measured at fair cost value with changes in value with changes in equity P&L29th March 2012Financial Asset Dr 100 100 100to Financial liability 100 100 10031st March 2012Financial Asset Dr 5to P&L A/c 5Financial Asset Dr 5To fair value reserve 5A/c2nd April 2012P&L A/c Dr 2To financial asset 2Fair value reserve Dr 2To financial asset 2Financial liability Dr 100 100 100To cash 100 100 100
Settlement date accounting:Date HTM investment AVS asset re- Assets at FVTPL re- carried at amortized measured at fair measured at fair cost value with changes in value with changes in equity P&L29th March 2012 No entry on trade No entry on trade No entry on trade date date date31st March 2012Receivables Dr 5to P&L A/c 5Receivables Dr 5To fair value reserve 5A/c2nd April 2012Financial Asset Dr 100To Financial 100liability/cash
Financial Asset Dr 103Fair value reserve A/c Dr 2 To financial liability/cash 100 To Receivable 5Financial Asset Dr 103Fair value reserve A/c Dr 2 To financial liability/cash 100 To Receivable 5
Initial and subsequent recognition and measurement of financial assets:A financial asset or financial liability at FVTPL should be measured at fair value on thedate of acquisition or issue.Short-term receivables and payable with no stated interest rate should be measured atinvoice amount if the effect of discounting is immaterial.Other financial asset or financial liability should be measured at fair value plus/minustransaction costs that are directly attributable to the acquisition or issue of financial assetor liability.Fair value:It is the amount at which an asset could be exchanged, or a liability settled, betweenknowledgeable, willing parties in an arm’s length transaction.Fair value hierarchy can be followed as under:Active market- quoted priceNo active market- valuation techniques- DCF, option pricing modelNo Active market- equity investment less impairment lossFair value concept presumes that the entity is a going concern. Therefore fair value isnot an amount that an entity would receive or pay in a forced transaction, involuntaryliquidation or distress sale.
Transaction cost:Transaction costs are the incremental costs that are directly attributable to theacquisition, issue or disposal of a financial asset or financial liability.The various transaction costs that an entity incurs in issuing financial instrument mightinclude:Registration and other regulatory feesPrinting costsStamp dutyTransaction cost of an equity transaction which are directly attributable to it and areincremental will be deducted from equity.
Category of financial Measurement at Measurement at Impairment test (ifassets initial recognition subsequent reporting objective evidence) dateFVTPL At fair value, on At fair value NoAll stand-alone acquisition date, Change in fair valuederivatives come here which is acquisition between two click here for example price. reporting dates is Directly attributable charged/credited to transaction cost is profit and loss A/c charged to profit and directly loss A/c separatelyAvailable for sale At fair value, on At fair value Yes acquisition date, Change in fair value which is acquisition between two price plus transaction reporting dates is Click here for example costs that are directly charged/credited to a attributable to separate component acquisition or issue of of equity, say, financial asset investment valuation reserve
Category of financial Measurement at Measurement at Impairment test (ifassets initial recognition subsequent reporting objective evidence) dateHeld to maturity At fair value, on At amortized cost Yes acquisition date, applying effective which is acquisition interest rate. price plus transaction costs that are directly Click here for example attributable to acquisition or issue of financial assetLoans and receivable Short term receivable At amortized cost Yes with no stated interest applying effective rate should be measured interest rate. at original invoice amount if the effect of discounting is Click here for example immaterial. Other items at fair value, on acquisition date, which is acquisition price plus transaction costs that are directly attributable to acquisition or issue of financial asset
Category of financial Measurement at Measurement at Impairment test (ifassets initial recognition subsequent reporting objective evidence) dateFinancial assets, fair At cost At cost Yesvalue of which can notbe reliably measured Click here to go to next slide
Example: Held for trading securities (FVTPL)A ltd began operations on January 1, 2012. during the year A ltd purchasedvarious marketable equity securities. The cost and fair value of these securitiesat the end of 2012 were as follows: Face value cost Market Unrealised loss gain P ltd Rs. 10 2000 2500 500 Q ltd Rs. 10 3000 2600 400 R ltd Rs. 10 1000 1200 200 S ltd Rs. 10 1500 1350 150 7500 7650 550 700
Solution:Adjusting entry Valuation Allowance Dr 150 (7650-7500) To Profit and Loss A/c 150Debit balance in Valuation Allowance A/c indicates fair value is larger than cost andcredit balance indicates fair value is less than cost. Dr. (Cr.)Trading securities A/c (cost) 7500Valuation Allowance 150Trading securities at fair value 7650A ltd’s securities would be reported on its December 31, 2012 balance sheet in theCurrent asset section at their fair value of Rs 7650. Click here to go back
Example: Available for saleAssume same information as given in previous example except that the securitiesqualify as available for sale.Solution:Adjusting entry Valuation Allowance Dr 150 (7650-7500) To Investment valuation reserve A/c 150Investment valuation reserve account is included in the stockholder’s equity sectionof the balance sheet.A ltd’s available for sale securities would be reported on it’s December 31, 2012balance sheet at their fair value of Rs 7650. Each security would be evaluated todetermine whether it should be classified in current asset or in non-current assets.Those that are expected to be sold within the next year should be included incurrent assets. The others should be included in non-current assets. Click here to go back
Example: Held to MaturityOn January 1, year 1, A ltd purchased Rs 100000 face value , 3 year, 8% bonds of B ltdfor Rs 94924 which provides an effective interest rate of 10%. The bonds pay interestsemi-annually on June 30 and December 31.Solution: Amortized schedule -effective interest method date cash interest effective interest Discount Carrying value of bonds (4% semi annually) (5% semi annually) Amortization or amortized cost 01/01 Yr 1 94924 30/06 Yr 1 4000 4746 746 95670 31/12 Yr 1 4000 4784 784 96454 30/06 Yr2 4000 4823 823 97276 31/12 Yr 2 4000 4864 864 98140 30/06 Yr 3 4000 4907 907 99047 31/12 Yr 3 4000 4952 952 100000Cash interest is to be calculated on face value and effective interest is to be calculatedon previous amortized cost.
Entries for the first year and maturity date:01/01/yr 1Investment in bonds Dr 94924 To Cash 94924(initial recording at fair value)30/06/Yr 1Cash Dr 4000Investment in bonds Dr 746 To Interest income 474631/12/Yr 1Cash Dr 4000 Click here to go backInvestment in bonds Dr 784 To Interest income 478431/12/Yr 3Cash Dr 4000Investment in bonds Dr 952 To Interest income 4952Cash Dr 100000 To Investment in binds 100000
Example: Loans and receivableA ltd grants Rs 10 lakhs loan to its employees on January 1, 2012 at a concessionalinterest rate of 4% p.a. Loan is to be repaid in five equal annual installments along withinterest. Market rate of interest for such loan is 10% p.a. At what value loan should berecognized initially and also calculate the amortized cost for all the subsequent fiveyears.Solution:(a) Calculation of initial recognition amount of loan that will be discounted present value of future cash flows from re-payment of the loan Year end Cash in flows Total Discount factor Discounted Principal Interest At 10% value 2012 200000 40000 240000 0.9090 218160 2013 200000 32000 232000 0.8263 191702 2014 200000 24000 224000 0.7512 168269 2015 200000 16000 216000 0.6829 147506 2016 200000 8000 208000 0.6208 129126 Present value or Fair value 854763
Entries1/1/2012Staff loan A/c Dr 1000000 To Bank 1000000Staff cost A/c Dr 145267 (1000000-854763) To staff loan 145267(loan will be initially recognized at its fair value i.e. Rs 854763 and balance amount willbe debited to staff cost)(b) Calculation of amortized cost at the end of each year Year Balance Interest to be Re-payment Amortized cost recognized (10%) (including interets) 2012 854763 85476 240000 700239 2013 700239 70024 232000 538263 2014 538263 53826 224000 368090 2015 368090 36809 216000 188899 2016 188899 18890 208000 NIL
Entry for 2012Staff loan A/c Dr 85476 To Interest on staff loan 85476Bank A/c Dr 240000 To staff loan 240000Interest on staff loan Dr 85476 To Profit & Loss A/c 85476 Click here to go back
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